Recent Posts

Many people complain about government control of currency, but
only a few do something about it. I’m not talking about movements
to “audit the Fed” and such. I’m talking about real innovation
that makes an end run around the government’s iron grip on the
monetary system.

A few of us old folks might like to return to the days of
slapping a silver dollar on the bar for a shot of whiskey, but
the younger techno-savvy generation sees paying for their Negroni
cocktail with virtual currency from their hand-held device. To
serve this market, a new world of virtual currencies has popped
up spontaneously.

In a debate, Mitt Romney said, “You couldn’t have people opening
up banks in their garage and making loans.”

Really? Some people are thinking precisely along these lines and
even going further to create new units of accounting.
You might think these people are crazy. After all, to be a proper
money, a currency must have a nonmonetary value, a high value per
unit weight, a fairly stable supply and be divisible, durable,
recognizable, and homogeneous. Gold and silver fit the bill
perfectly. But does that mean something else (or a variety of
things) can’t?

Money develops from being the most marketable good that in turn
is used for indirect trade. Historically, that has been gold and
silver. However, governments have worked very hard to demonetize
gold and silver with taxes on precious metals and legal tender
laws. And while a few people swear by storing their wealth in
gold and silver, in relation to all other financial assets, the
percentage of portfolios invested in precious metals is only 1%.

The idea that government is going to re-shackle its currency to
gold anytime soon, when the only way federal governments are
staying in business is with an unfettered printing press, is
naive. Governments always have driven and will keep driving the
value of their currencies to the value of the paper. It may take
decades, it may take centuries, but it will happen eventually.

The answer to the currency question may not be to reform
government in a way that it can’t reasonably be reformed, but to
turn loose entrepreneurial genius to solve the problem and create
a quality product. There are plenty of government roadblocks, but
every new innovation encounters government resistance.
Entrepreneurs persevere. However, this is a particularly risky
area. There are currency entrepreneurs sitting in jail for
competing with the government.

In 2009, Japanese programmer “Satoshi Nakamoto” (not his real
name) was designing and implementing Bitcoin. It’s not for the
faint of heart. It’s proven to be highly volatile. But it’s also
proven to be very useful in a digital age.

Some people in the free-market community don’t know what to think
of Bitcoin and have dismissed it. They say no currency can exist
that doesn’t have a prior root in physical commodity.

That is because, as Robert Murphy summarized Ludwig von Mises:
“We can trace the purchasing power of money back through time
until we reach the point at which people first emerged from a
state of barter. And at that point, the purchasing power of the
money commodity can be explained in just the same way that the
exchange value of any commodity is explained.”

The naysayers contend Bitcoins never had a nonmonetary commodity
value. The case for it is then dismissed without thought or
argument. However, Mises built his “regression theorem” on the
work of Carl Menger, the father of Austrian economics and
subjective value.

In Menger’s view, economizing individuals constantly look to make
their lives better through trade. These individuals trade less
tradable goods for more tradeable goods. What makes goods more
tradeable, Menger emphasizes, is custom in a particular locale.

“But the actual performance of exchange operations of this kind
presupposes a knowledge of their interest on the part of
economizing individuals,” Menger writes. But Menger goes on to
explain that not all individuals gain this knowledge all at once.
A small number of people recognize the marketability of certain
goods before most others.

These might be considered currency entrepreneurs. They anticipate
consumer needs and demands, and as is the case with any other
good or service, these entrepreneurs recognized more salable
goods before the majority of people.

“Since there is no better way in which men can become enlightened
about their economic interests than by observation of the
economic success of those who employ the correct means of
achieving their ends, it is evident that nothing favored the rise
of money so much as the long-practiced and economically
profitable acceptance of eminently saleable commodities in
exchange for all others by the most discerning and most capable
economizing individuals.”

For example, cattle were, at one time, the most saleable
commodity and were thus considered money. Although cattle money
sounds unwieldy, the Greeks and the Arabs were both on the cattle
standard. This currency had four legs that could move itself, and
grass was everywhere, so feeding it was inexpensive.

But then the division of labor led to the formation of cities,
and the practicality of cattle money was over. Cattle were no
longer marketable enough to be money. Cattle still had value,
but, “They ceased to be the most saleable of commodities, the
economic form of money, and finally ceased to be money at all,”
Menger explains.

Then began the use of metals as money: Copper, brass and iron,
and then silver and gold.

But Menger was quick to point out that various goods served as
money in different locales.

“Thus money presents itself to us, in its special locally and
temporally different forms, not as the result of an agreement,
legislative compulsion, or mere chance, but as the natural
product of differences in the economic situation of different
peoples at the same time, or of the same people in different
periods of their history.”

So while people contend that money must be this or must be that,
or come from here, or evolve from there, Menger, the father of
the Austrian school, seems to leave it up to the market. When a
money becomes uneconomic to use, it loses its marketability and
ceases to be money. Other marketable goods emerge as money. It’s
happened throughout history and likely will continue, despite
government wanting to freeze the world in place to its liking.

Which brings us back to Bitcoin, what the European Central Bank
(ECB) calls in its latest report “the most
successful — and probably most controversial — virtual currency
scheme to date.”

Ironically, while some economists are pooh-poohing Bitcoin, the
ECB devotes some of their lengthy report to the idea that the
Austrian school of economics provides the theoretical roots for
the virtual currency. The business cycle theory of Mises, Hayek
and Bohm-Bawerk is explained in the report and Hayek’s
Denationalisation of Money is mentioned.

The report writers indicate that Bitcoin supporters see the
virtual currency as a starting point for ending central bank
money monopolies. Like Austrians, they criticize the
fractional-reserve banking system and see the scheme as inspired
by the classic gold standard.

Bitcoins are already used on a global basis. They can be traded
for all sorts of products, both material and virtual. Bitcoins
are divisible to eight decimal places and thus can be used for
any size or type of transaction.

Bitcoins are not pegged to any government currency and there is
no central clearinghouse or monetary authority. Its exchange rate
is determined by supply and demand through the several exchange
platforms that operate in real time. Bitcoin is based on a
decentralized peer-to-peer network. There are no financial
institutions involved. Bitcoin’s users take care of these tasks
themselves.

Additional Bitcoin supply can only be created by “miners” solving
specific mathematical problems. There are somewhere around 10
million Bitcoins currently in existence, and more will be
released until a total of 21 million have been created by the
year 2140. According to Bitcoin’s creator (whomever he or she
is), mining on Bitcoin provides incentives to be honest:

“If a greedy attacker is able to assemble more CPU power than all
the honest nodes, he would have to choose between using it to
defraud people by stealing back his payments, or by using it to
generate new coins. He ought to find it more profitable to play
by the rules, such rules that favour him with more new coins than
everyone else combined, than to undermine the system and the
validity of his own wealth”.

The ECB’s report explains that Bitcoin supply is designed to grow
in a predictable fashion. “The algorithms to be solved (i.e., the
new blocks to be discovered) in order to receive newly created
Bitcoins become more and more complex (more computing resources
are needed).”

This steady supply increase is to avoid inflation (decrease in
the value of Bitcoins) and business cycles caused when monetary
authorities rapidly expand money supplies.

Bitcoin has become the currency of the online black market. For
instance, The Silk Road (the Amazon of the illegal drug trade
that can only be accessed through private networks using the IP
scrambling service called Tor) only accepts payments in Bitcoin.
However, as the ECB report points out, there are only about
10,000 Bitcoin users, and the market is illiquid and immature.

So why does the ECB give a damn about Bitcoin and other virtual
currencies? The central bankers are worried that they are not
regulated or closely supervised, that they could represent a
challenge for public authorities and that they could have a
negative impact on the reputation of central banks.

At the same time, the report makes the point that “these schemes
can have positive aspects in terms of financial innovation and
the provision of additional payment alternatives for consumers.”

The report says big players in the financial services arena are
purchasing companies in the virtual payments space. VISA acquired
PlaySpan Inc., a company with a payment platform that handles
transactions for digital goods.

American Express (Amex) purchased Sometrics, a company “that
helps video game makers establish virtual currencies and… plans
to build a virtual currency platform in other industries, taking
advantage of its merchant relationships.”

This would dovetail with American Express’ entry into the prepaid
credit card business. Banking industry insiders are upset with
Amex and Wal-Mart, that also is offering prepaid cards, because
these prepaid accounts would amount to uninsured deposits,
according to Andrew Kahr, who wrote a scathing piece on the issue
for American Banker.

Kahr rips into the idea with this analogy:

“To provide even lower ‘discount prices,’ should Wal-Mart rent
decaying buildings that don’t satisfy local fire laws and
building codes — and offer still better deals to consumers? And
why should Walmart have to honor the national minimum wage law,
any more than Amex honors state banking statutes? With Bluebird,
Amex can already violate both the Bank Holding Company Act and
many state banking statues.”

Kahr is implying that regulated fractionalized banking is safe
and sound, while prepaid cards provided by huge companies like
Amex and Wal-Mart is a shady scheme set up to rip off consumers.
The fact is, in the case of IndyMac, panicked customers forced
regulators to close the S&L by withdrawing only 7% of the
huge S&L’s deposits. It was about the same for WaMu and
Wachovia when regulators engineered sales of those banks being
run on. Bitcoin supporters, unlike the general public, are well
aware of fractionalized banking’s fragility.

Maybe what the banking industry is really afraid of is the Amexes
and Wal-Marts of the world creating their own currencies and
banking systems. Wal-Mart has tried to get approval to open a
bank for years, and bankers have successfully stopped the retail
giant for competing with them.

However, prepaid credit cards might be just the first step toward
Wal-Mart issuing their own currency — Marts — that might
initially be used only for purchases in Wal-Mart stores. But over
time, it’s not hard to imagine Marts being traded all over town
and easily converted to dollars, pesos, Yuan, or other currencies
traded where Wal-Mart has stores.

Governments are destroying their currencies, and businesses know
it. Entrepreneurs won’t just stand by and theorize. They’re doing
something. They recognize a market opportunity. The banking
industry realizes it. As Mr. Kahr concluded his article that
calls for an end to all uninsured deposits: “Otherwise, we might
have an unregulated Facebook or Google of payments, even PayPal,
quickly becoming both highly vulnerable and TBTF. (It could
actually be run by someone wearing a hoodie, without tie or even
white shirt!)”

Here at LFB, we don’t know what tomorrow’s money will be. Digits
and computer algorithms? Silver and gold coins engraved with
someone wearing a hoodie, perhaps? What we know for sure is that
we’re rooting for enterprising entrepreneurs to give the
government a run for their money in the money business. Watch
this space.